“Understanding and mitigating risk to protect and enhance the shareholders’ investment.”
Coal price volatility and environmental challenges against coal usage resulted in risks to the coal industry’s growth. The strategy of developing Adaro Group’s business model by integrating three pillars of growth: coal mining, mining services and logistics, and power, becomes a ‘natural hedge’ to address the coal price risk. An increase of coal price will benefit the first engine (coal mining) while a decrease of coal price could benefit the third engine (power). The strategy also provides a measure of control on the coal supply chain.
The coal price decline in recent years provided the company with an opportunity to increase its coal reserves by acquiring PT Semesta Centramas, PT Laskar Semesta Alam, PT Paramitha Cipta Sentosa (Balangan Coal Companies) and the IndoMet Coal Project so that the customers’ requirements can be better protected.
Currently, the Adaro Group has 76 risk champions throughout its subsidiaries. Every subsidiary and division has at least two risk champions. They are responsible for facilitating the risk assessment processes, aligning the risk profile with the annual plan and budget, and ensuring there are mitigations of the key risks in each organization.
As shown in the following table, there are 9 types of risks that are critical and high level. These risks are our major focus, while the other 20 types of risk are of a moderate and low level.
Risks in our focus
Risks in our focus:
Changes in the company’s long term industry, such as environmental challenges on the use of coal, the availability of alternative energy and coal price decline.
The company’s level of dependency on coal mining assets has changed. In 2009, our revenues were highly dependent on coal mining assets at 84% of EBITDA. In 2016 they became 69% of EBITDA, with the rest of the revenue being from mining services and logistics, and power.
In the power sector, we also consider alternative energy sources such as gas and solar. Furthermore we are also diversifying by developing potential businesses in metallurgical coal and water treatment industries.
Project failures include project completion delays, costs overrun and completion quality below specification.
Two major ongoing projects are a 2 x 1,000 MW steam power plant in Batang, Central Java and a 2 x 100 MW steam power plant project in South Kalimantan, which both started construction in June 2016.
The construction of both projects are being carried out by engineering, procurement and construction (EPC) contractors who have a sound reputation and good track records so that the projects are expected to be completed on budget, specifications and time. The contractors are Mitsubishi Hitachi Power Systems, Ltd. and Sumitomo Corporation for the 2 x 1,000 MW Batang, Central Java power plant and Hyundai Engineering, Co. Ltd., for the 2 x 100 MW power plant in South Kalimantan.
3. Joint Venture Investment
The risk from investing in joint venture companies is associated with the success in generating returns from the investments.
Some of our joint venture (JV) subsidiaries have not yet been able to contribute return on investment, which are PT Mustika Indah Permai, PT Bukit Enim Energy, and PT Bhakti Energi Persada. Balangan Coal Companies is one JV that has contributed return and generated operating profit.
The delays of the other JVs are mainly due to the decline in coal price which has made coal mines in those JVs uneconomic. Projects to build mine mouth power plants in South Sumatera and East Kalimantan are expected to address this issue.
IndoMet Coal Project is no longer a JV as ATA and CTI acquired the 75% ownership of BHP Billiton in the JV on October 14th, 2016 and IndoMet Coal Project (now Adaro MetCoal Companies - AMC) became wholly owned by AE.
4. Regulatory changes
Changes in laws and regulations can affect the company’s ability to complete important transactions, enforce contracts or implement its specific strategies and activities.
The Government is currently supporting the industries in which Adaro Group operates by:
- Law No. 2, 2012 on Land Procurement for Development in the Public Interest: land availability for power plant development.
- Government Regulation No. 79, 2014 on the National Energy Policy: achieving optimal primary energy mix, including the role of coal energy up to 2050.
- Presidential Regulation No. 2, 2015 on the National Medium-Term Development Plan Year 2015-2019: consists of coal production target determination in 2015 – 2019.
- Government program on 35,000 MW: related to the power plant development opportunity.
PT Adaro Indonesia (AI) is now ready to sign an amendment of the Coal Contract of Work (CCoW) agreement. The contract amendment is a mandate of the Law No. 4, 2009 on Mineral and Coal Mining. The discussions between AI and the government regarding the amendment were done in 2014 and an agreement has been concluded and set out in a memorandum of understanding (MoU) of contract amendment.
Additionally, there are potential changes to government regulations that can affect the implementation of our strategies.
5. Coal reserves
The availability of coal reserves is important to meet both domestic and foreign customers’ needs. In order to maintain long term availability of adequate reserves, we have acquired the coal mines of Balangan Coal Companies and IndoMet Coal Project (now AMC). These have started production and complement our organic growth.
For detailed information on coal reserves please see page number 76.
6. Business interruption
Damage of the major facilities and infrastructure such as bridges, hauling road, coal handling terminal or a channel blockage can cause operational activities to be stopped for a period of time.
At the end of 2015, the Board of Directors of AE issued a Crisis Management Policy that requires the subsidiaries to identify crisis events (e.g. natural disasters, explosions, fires, terrorism), that may become a crisis situation, and make a crisis management plan as well as hold training exercises so that a crisis can be responded to as soon as possible. Currently only the major subsidiaries have completed this identification but in 2017 we expect it to be implemented by all subsidiaries.
Adaro Group has insurance programs in place to cope with business interruption resulting from the damage to critical facilities.
7. Legal and regulatory compliance
There are ministerial, regional and other types of regulations that must be complied with by the company. Non-compliance of the regulations could lead to sanctions, legal costs, and other adverse effects, as well as reputational loss.
Each of AE’s subsidiaries must ensure that its activities fully comply with the relevant laws and regulations.
AE has a Legal and Compliance team to support subsidiaries in complying with the applicable regulations.
8. Health, safety and environment
It is our obligation to provide a work environment that takes into account the health, safety and the environment for both employees and the surrounding community. We strive to achieve zero harm in terms of employees’ work safety and health as well as to minimize operational impact on the environment.
For more detail, see page 186 in our Quality, Health, Safety and Environment section of this report.
9. Community relations
Community relations issues are an aspect common to all mining companies. It is related to the support of the local community and Government to the company’s operations so that the company’s operations run smoothly.
For more detailed explanation, see page 200 in our Creating Shared Value section of this report.
Effectiveness of Risk Management Implementation
Below are the main principles of risk management set out in our risk management policy:
understood before making key business decisions.
integrated into the management cycle of the company and embedded in planning processes, at both the operational and strategic level.
3. Being part of decision making
used in selecting appropriate decisions by taking into account the information on the risk exposure of every option.
managed to address uncertainty, put control mechanism, maximize opportunity and minimize negative impact.
5. Systematic, structured and timely
applied in a systematic, structured and timely manner across the Adaro Group to ensure efficient and reliable results.
6. Based on the best available information
managed using the best available relevant information with the awareness that some key information cannot be obtained.
7. Inclusive and transparent
engaging internal and external stakeholders in each step of risk management process and being transparent about all mitigation actions and the progress
8. Reassessed periodically
re-assessed periodically to identify whether there are new risks and risks that are no longer relevant.
communicated with the relevant stakeholders in order to obtain appropriate responses so that risks can be mitigated effectively.
Based on the explanation presented in this section, it can be concluded that has implemented effective risk management that conforms to the company’s principles of risk management.